Module 6:

Management Accounting II:

Cost-Volume-Profit Analysis
November 3, 2021
 Cost-Volume-Profit Relationships
Cost-volume-profit
Cost-volume-profit (CVP) (CVP) analysis
analysis is
is used
used to
to
answer
answer questions
questions suchsuch as:
as:
–– How
How muchmuch must
must II sell
sell to
to earn
earn my
my desired
desired
income?
income?
–– How
How willwill income
income be be affected
affected
if
if II reduce
reduce selling
selling prices
prices toto
increase
increase sales
sales volume?
volume?
–– What
What willwill happen
happen to to
profitability
profitability if if II expand
expand
capacity?
capacity?
 The Use of Cost Data in Decision Making
 You’ve seen that the quarterly or year end Balance Sheet
and Income Statement are the result of classifying and
aggregating numerous accounting transactions
 This same accounting data, when properly arranged,
provides an immense source of information that can be
used for setting budgets, evaluating performance of
processes, departments and people and decision making
 Today, we’ll examine some of these decision elements

First, let’s review some

terminology
Fixed Costs

Total fixed costs remain unchanged

when activity changes.
Cell Phone Bill
Monthly Basic

Your monthly basic

cell phone bill probably
does not change when
Number of Local Calls
you make more local calls
Fixed Costs

Fixed costs per unit decline as activity increases.

Monthly Basic Cell Phone

Bill per Local Call
Your average cost per
local call decreases as
more local calls are made. Number of Local Calls
Variable Costs
Total variable costs change when activity changes.
Total Long Distance
Cell Phone Bill

Your total long distance

cell phone bill is based
on how many minutes
Minutes Talked you talk
Variable Costs
Variable costs per unit do not change
as activity increases.

Cell Phone Charge

Per Minute
The cost per long distance
minute talked is constant. Minutes Talked
For example, 10
cents per minute.
 Semivariable Costs (Mixed Costs)
Mixed costs contain a fixed portion that is
incurred even when facility is unused, and a
variable portion that increases with usage.

Example: Monthly electric utility charge

 Fixed service fee

 Variable charge per

kilowatt hour used
 Semivariable Costs (Mixed Costs)
Total Utility Cost

o st
dc
i xe
t alm Variable
T o
Utility Charge

Fixed Monthly
Utility Charge
Activity (Kilowatt Hours)
How do we determine
semi-variable
cost elements?
Determining Cost Behaviour
The long run average production activity of
Department A is 8,000 direct labour hours
per month which is 80% of its practical
capacity. The expected activity this month is
9,000 hours and the overhead budget for this
level of activity is set at $63,450. Department
A’s overhead budget at average activity levels
is $59,200.

What are the variable and fixed costs implied

by the above information?
 Hi Lo Method or
Rise/Run or Slope to get Variable Cost
Variable Component = Change in Cost/Change in Activity
($63,450-$59,200)/(9000-8000) =$4.25/DL Hr

Fixed Component = Total Cost - Variable Cost

(take 9,000 level) $63,450 - $4.25(9000) = $25,200
(or 8,000 level) $59,200 - $4.25(8000) = $25,200

Cost Behaviour Equation. y = a + bX

y=$25,200 + $4.25 X # of DL Hours

Where y = total cost; a = fixed cost and

b = variable cost/hr
The long run average production activity of Department A is 8,000
direct labour hours per month which is 80% of its practical capacity.
The expected activity this month is 9,000 hours and the overhead
budget for this level of activity is set at $63,450. Department A’s
overhead budget at average activity levels is $59,200.
 Question Time

Agree or disagree? Variable cost per

unit remains the same for different levels
of production but fixed cost per unit
decreases with increases in production.
Cost Behavior Summary
 Another Question Time

Finally, we often believe that volume of

production or service is the key driver of
costs. However, there are other drivers
of cost than simply volume of output.
Can you name a few?
 Economies of Scale

Think
Think of
of aa Monthly
Monthly Rent
Rent or
or Lease
Lease

Cost per unit sold or cost

per client serviced
Fixed
Fixed costs
costs per
per unit
unit
decline
decline as
as activity
activity
increases
increases Number of units sold
or Clients Serviced
Economies of Scale

Economies
Economies of
of scale
scale are
are most
most apparent
apparent
in
in business
business with
with high
high fixed
fixed costs.
costs.

Utility Steel
Companies Mills

Oil
Airlines
Refineries
Economies of Scale

Economies
Economies of
of scale
scale are
are most
most apparent
apparent
in
in business
business with
with high
high fixed
fixed costs.
costs.
Number
Fixed Costs of Flights Fixed Cost
per Month per Month per Flight
$ 10,000,000 1,000 $ 10,000
$ 10,000,000 2,000 $ 5,000
$ 10,000,000 4,000 $ 2,500
$ 10,000,000 8,000 $ 1,250

Airlines
Airlines
Reporting Results
From Financial to Managerial Accounting

Financial Accounting Managerial Accounting

Sales Sales
- Cost of Goods Sold - Variable costs
= Gross margin = Contribution margin
- Selling and Admin - Fixed costs
= Income = Income
 Cost-Volume Profit Analysis or Contribution Margin
Analysis

Purpose:
 To determine an organization’s short run contribution to fixed
overheads and profit.
Requirements:
 An understanding of cost and price behaviour patterns at various
levels of activity.
 This understanding comes from:

 Previous Financial Reports

 Informed Judgment

 Statistical Techniques

 Pricing Experiments
Some Important Terms

 What is contribution margin?

 What is contribution margin ratio?
 What is the breakeven point?

 What is profit margin?

 What is margin of safety?
Cost Volume Profit Calculations
Equation Method
Revenue = Variable + Fixed + Operating
Costs Costs Income

Contribution Approaches
Breakeven Sales = Fixed Costs
in units Contribution Margin per Unit

Breakeven Sales = Fixed Costs

in dollars Contribution Margin Ratio

Target Unit Sales = Fixed Costs + Operating Income

Contribution Margin per Unit
 Let’s do an Example
A BE 601 duo have recently decided that their idea is so good that they have formed a company,
BE601 Duo Creations, and are moving to the production phase. They have convinced others of the
merits of their idea and have raised enough capital to get underway. They estimate that they can sell
50,000 units of their creation this year. Here is some additional data:

Cost and revenues per each of the Duo’s creations

Selling Price $50.00
Variable Costs:
Materials $15.00
Direct Labour $12.00
Manufacturing support $ 8.00
Selling expenses $ 2.00
Total Variable Cost $37.00
Annual Fixed Costs:
Manufacturing support $160,000
Selling and Administrative $120,000
Total Fixed Costs $280,000
1. What is the Duo’s contribution margin/unit? CM Ratio? Breakeven point in units? In dollars?
2. How much profit will the Duo’s make if they sell their anticipated 50,000 creations?
3. What would their margin of safety be if they sold 25,000 creations?
4. How many of the Duo’s creations must be sold to make a profit of $175,000
5. How many of the Duo’s creations must be sold to generate a pretax profit margin (profit/sales) of 12%?
However, we live in a world of tax. If the Duo’s effective tax rate is 20%, what must they sell to achieve
an after tax profit margin of 12%
6. Assume the Duo’s backers provided $300,000 to get the Duo’s going. They want a 30% return on their
investment and the Duo feel they need $70K per year to support their life style. Is this feasible?
1a. What is the Duo’s contribution
margin/unit?

1b Contribution margin ratio?

1c Breakeven point in units?

1d Breakeven point in dollars?

2. Profit = Revenue - Variable Costs - Fixed Costs

3. Margin of safety = Actual sales volume – BE sales volume

4. How many of the Duo’s creations must be sold to make a

profit of $175,000?
5a. How many of creations must be sold to generate a
pre-tax profit margin of 12%

5b. How many creations must be sold to generate an

after-tax profit margin of 12%
6. Assume their backers provided $300,000 to get
the Duo going. They want a 30% return and the
partners feel they need $70K per year to live on. Is
this feasible?
Let’s do a Quick Quiz
Question #1
ABC
ABC Co.
Co. sells
sells product
product XYZ
XYZ at
at $5.00
$5.00 per
per unit.
unit. If
If
fixed
fixed costs
costs are
are $200,000
$200,000 and
and variable
variable costs
costs are
are
$3.00
$3.00 per
per unit,
unit, how
how many
many units
units must
must be
be sold
sold to
to
break
break even?
even?

a.
a. 100,000
100,000 units
units
b.
b. 40,000
40,000 units
units
c.
c. 200,000
200,000 units
units
d.
d. 66,667
66,667 units
units
Question #2
Use
Use the
the contribution
contribution margin
margin ratio
ratio formula
formula toto
determine
determine the
the amount
amount ofof sales
sales revenue
revenue ABC
ABC must
must
have
have to
to break
break even.
even. All
All information
information remains
remains
unchanged:
unchanged: fixed
fixed costs
costs are
are $200,000;
$200,000; unitunit sales
sales
price
price is
is $5.00;
$5.00; and
and unit
unit variable
variable cost
cost is
is $3.00.
$3.00.

a.
a. $200,000
$200,000
b.
b. $300,000
$300,000
c.
c. $400,000
$400,000
d.
d. $500,000
$500,000
Question #3

If
If sales
sales commissions
commissions areare $10,000
$10,000 when
when 80,000
80,000
units
units are
are sold
sold and
and $14,000
$14,000 when
when 120,000
120,000 units
units
are
are sold,
sold, what
what is
is the
the variable
variable portion
portion of
of sales
sales
commission
commission per unit sold?

a.
a. $.08
$.08 per
per unit
unit
b.
b. $.10
$.10 per
per unit
unit
c.
c. $.12
$.12 per
per unit
unit
d.
d. $.125
$.125 per
per unit
unit
Question #4

If sales commissions are $10,000 when

80,000 units are sold and $14,000
when 120,000 units are sold, what is the
fixed portion of the sales commission?
a. $ 2,000
b. $ 4,000
c. $10,000
d. $12,000
Question #5
Last year, Twins Company reported $750,000 in sales (25,000 units)
and a net income of $25,000. At the break-even point, the company's
total contribution margin equals $500,000. Based on this information,
which of the following statements is true?
A. The company's contribution margin ratio is 40%.
B. The company's break-even point is 24,000 units.
C. The company's variable expense per unit is $9.
D. The company's variable expenses are 60% of sales.
E. None of the above are true.
Let’s do / take up the following in Connect:
 Problem 20.2A
Reminders
 Module 6 assignment due on October 31st at 9pm EDT in
Connect
 Module 7 opens tomorrow (Thursday) at 12:01am EDT

1) COMPLETE the Module 7 Requirements as detailed in the

Class Schedule before our next class on November 10th: i)
Chapter 21 readings in e-book; ii) Read PowerPoint
Presentation and Notes in Slides in LEARN; iii) Do Smartbook
Assignment in Connect; and iv) Do Ungraded Practice
Questions in Connect

2) Complete the Module 6 Assignment by November 7th at

9pm EST in Connect
QUESTIONS?